3.3.2 Costs

Question 1

What is a fixed cost?

Answer 1

One which does not change directly with output

Question 2

Examples of fixed costs

Answer 2

• rent
• insurance rates
• salaried staff

Question 3

Fixed costs for businesses

Answer 3

• they do not vary directly with level of output = treated independent of level of production
• must be payed whether or not the firm produces nothing or operates at full capacity

Question 4

How to calculate average fixed costs (ATC)?

Answer 4

total fixed cost/ output

Question 5

What are variable costs?

Answer 5

One which does change directly with output

Question 6

Examples of variable costs

Answer 6

• raw materials
• hours paid/ zero hours workers

Question 7

How to calculate total costs?

Answer 7

Fixed costs (TFC) + variable costs (TVC)

Question 8

How to calculate average cost?

Answer 8

TC/output

Question 9

How to calculate Average fixed cost?

Answer 9

TFC/output

Question 10

How to calculate average variable cost?

Answer 10

TVC/output

Question 11

What will happen to AFC as output increases?

Answer 11

It will decrease

Question 12

What is the economic theory?

Answer 12

• in the short run, at least one factor input is fixed, some costs will also be fixed
• in the long run, as all factor inputs are variable, so all costs are variable

Question 13

What is marginal cost?

Answer 13

The cost of producing an additional unit of output

Question 14

How to calculate marginal costs?

Answer 14

Change in total cost/ change in output

Question 15

What is the law of diminishing returns?

Answer 15

Derivation of short run cost curves from the assumption of diminishing marginal productivity

Question 16

What is diminishing marginal productivity?

Answer 16

• as more of a variable factor (e.g. labour) is added to fixed factors (e.g. capital), there will initially be an increase in productivity
• HOWEVER a point will be reached where additional units begin to decrease productivity

Question 17

Impact of diminishing marginal productivity on marginal costs?

Answer 17

• marginal costs increase when DMP occurs
• e.g. increase in labour = diminishing return as each additional worker is adding less to total output
• MC assumes all workers are paid the same = increase in MC

Question 18

What is marginal physical product?

Answer 18

The amount of units an extra worker produces

Question 19

How is marginal physical product calculated?

Answer 19

Difference in total output by each additional worker

Question 20

R/ship between law of diminishing returns and short run?

Answer 20

• short run = at least on factor of production is fixed
• MPP + diminishing marginal productivity only occurs in the short run
• as more labour is added to a fixed amount of capital or land, it is inevitable that output from an additional worker will fall at some point